Et Tu, Laffer?

Subtitle: Arthur Laffer Makes Me Chuckle

A common mistake made by economists is assuming that economic policies have the same effect under all economic conditions. But it’s not true. It is a general principle that water will turn to ice if the temperature is reduced. But that general principle does not hold true if the temperature is reduced from 95 degrees to 40 degrees. Only when the temperature declines to 32 degrees or below will any ice form.

Similarly, the effectiveness of fiscal and monetary policy varies depending on current economic conditions. Policies to curb inflation are helpful during periods of high inflation, but during periods of deflation they could be harmful. Tax cuts generally result in increase net after tax income, but during periods of losses, there is no effect.

One would think that Arthur Laffer, an educated economist who has practiced the craft for decades, would get it. Instead he fails to consider the current economic conditions while advocating policies. Laffer writes a column http://tinyurl.com/2auuu6g in the Wall Street Journal advocating that unemployment insurance benefits cause higher unemployment.

Under healthy economic conditions, it’s a sound theory. Higher unemployment benefits make unemployment more attractive thereby increasing the incentive to remain unemployed and decreasing the incentive to look for a new job. Laffer imagines unemployment benefits of $150,000 per year and correctly guesses that the unemployment rate would be higher if such a generous unemployment benefit were offered.

Laffer offers a chart that shows the correlation between increased unemployment benefits and unemployment. A glance at the chart shows that the more unemployment benefits are paid, the higher the unemployment rate rises. Laffer uses this to prove that high unemployment benefit payments cause unemployment.


And this is what is most annoying. He wants his audience to conclude that unemployment benefits cause unemployment. Of course, a closer look at his chart shows that the unemployment rate actually rose BEFORE unemployment benefits rose. How can an increase in unemployment benefits in 1975 cause unemployment to rise in 1974? It’s clear from Laffer’s chart and from just plain common sense that high unemployment is the cause and high unemployment benefit payments are the effect. For Laffer to suggest otherwise tells me that he is being dishonest.

Another policy about which he is clueless is stimulus. He believes that if the government spends money on stimulus, such as unemployment benefits, then the money must come out of the pocket of some other productive participant in the economy. This assumption also holds true under normal circumstances. In order to pay Peter, the government must tax Paul. It makes sense.

But it’s not always true. Currently, financial institutions are hoarding trillions of dollars that are not being invested in the economy. This normally causes deflation. However, the Federal Reserve is operating an anti-deflation policy. Bonds issues to pay for the Federal deficit are being bought up by the Fed. The money for the stimulus is not being taken out of anyone’s pocket.

We’re all familiar with the Laffer Curve. Lower taxes leave more money for businesses and productive individuals to invest and create an incentive for businesses. That’s sound economic theory. I’ve always had a lot of respect for Laffer. But this column is pathetic, and his use of deceit and his display of ignorance with respect to economics causes me to question his integrity as well as his competence. 

Kudlow Wrong Again: Unemployment Benefits

As of June 30, Congress has not passed a bill to extend unemployment benefits to those chronically unemployed. For millions of Americans, their unemployment benefits may run out before they are able to find a job.

To Larry Kudlow, this is a good thing: http://tinyurl.com/yapyroo

It’s an economic principle that if you subsidize something, then you get more of it. If you pay people not to work, then some people would prefer to sit on the couch watching reruns of American Idol than get out and look for a job. It’s a sound economic theory.

But Kudlow is wrong. Unemployment is not a subsidy. It’s insurance. Employers pay insurance premiums. The premiums depend on number of employees, salaries and history. If an employer has a history of a lot of layoffs, then their premiums go up. The unemployed are merely collecting an insurance payout.

As Kevin Williamson explained in a recent column at NationalReview.com, “unemployment benefits are one of the better social safety-net programs we have in the United States. They’re not terribly expensive, in real terms; they reward work; and they have the happy effect of encouraging a dynamic labor market and supporting risk-takers who seek better lives in new jobs.”

It’s true that some jurisdictions have generous unemployment benefits. New Jersey pays up to $600 per month. That’s $30k per year pace. That’s nice. But you won’t get the full amount unless you’ve been making $50 k or more over the prior year. Minimum wage workers won’t be able to get the entire amount, only 60% of prior earnings. That’s still not bad. Certainly some people might be tempted to take the benefit rather than make a real effort in looking for work. One can understand how overly generous unemployment benefits might cause an increase in unemployment.

But like many sound economic theories, it only works under certain conditions. Under normal conditions, it’s valid. But in a depressed economy with high unemployment, its effect on unemployment is minimal. How many of those slackers would be able to find a job even if they tried? If the jobs aren’t available, then the unemployed aren’t going to be able to go back to work even if they wanted to. Cutting their benefits in an effort to reduce unemployment and stimulate the economy is ludicrous. Kudlow makes it seem as if there are employers out there unable to fill open positions because the millions of unemployed workers are happily collecting benefits and have no desire to return to work.

Under a healthy economy, long periods of generous unemployment benefits may cause a slight increase in unemployment. But in an economy with nearly 10% unemployment, little to no growth in private sector jobs and slow growth, it’s stupid to suggest that generous unemployment benefits are a significant factor in the high rate of unemployment.

More On Kudlow's Ignorance: Gold and Inflation

Lawrence Kudlow has no degree in economics. He's a history major, but he portrays himself as some sort of economic expert on his CNBC show "Kudlow and Company" and in his columns which are picked up by National Review and Townhall. Kudlow is America's foremost economic pop-hack, and it's to the detriment of our society that he receives so much attention.

Here's an article http://tinyurl.com/38697k where Kudlow berates those who were predicting an economic recession saying that they would "windup with egg on their faces". Kudlow's column was dated December 7, 2007.  He predicts an ongoing "Bush Boom". He concludes, "There's no recession coming. The pessimistas [sic] were wrong. It's not going to happen... The Bush boom is alive and well."

We all know now that the National Bureau of Economic Research declared that the U.S. economic recession started in December, 2007, as Kudlow was writing his snide column. Predicting the economy is difficult, and even the brightest are wrong sometimes, but Kudlow would be wise to listen to real economists rather than criticizing them.  The fact is that in 2007 there were indicators of recession.  Kudlow addressed none of them in his column.

An issue that he has been harping on lately is inflation. Deflation was a major problem during the Great Depression, and some believe that the problem may have contributed to the prolongation of the Great Depression. Ben Bernanke is well aware of this as he has done extensive research on the subject. Bernanke has implemented an "easy money" policy which would be inflationary in a normal economy, but with banks reluctant to loan and cash heavy businesses reluctant to invest, the policy combats deflation.

But Kudlow sees inflation, not deflation, as the U.S. economy's greatest monetary threat. He has been extremely critical of Bernanke just as he was critical of those who were predicting a recession in December, 2007. He has even called for Bernanke to withdraw from his nomination for Fed Chief. Bernanke wisely ignored Kudlow's advice and was confirmed easily.

And he bases his fear of inflation on little more than the price of gold. Just this week http://tinyurl.com/2a7zcro Kudlow pointed to the rising price of gold as an indicator of inflation. Writes Kudlow:

"Gold prices are continuing to rally ... the surge is a bad economic omen... Rising gold prices are signaling higher inflation down the road..."

It is a sound economic theory that rising inflation causes the nominal price of gold to increase. Kudlow may have picked up on this by overhearing a conversation between two real economists or he may have  gotten it from a bumper sticker. Who knows? Kudlow's folly is that he is ignorant to the fact that other variables also cause the price of gold to increase; other factors that are currently in place in the current state of the economy.

Gold as an investment is typically looked at as a hedge, a hedge against inflation as well as a hedge against other threats. Put some of your savings in gold, and in the event of inflation, then the nominal value of said gold will increase. It's a hedge against inflation. It's also a hedge against risky investments and an unpredictable stock market.

Here is what Ben Bernanke said two weeks ago:

"I do think that there is a great deal of uncertainty and anxiety in financial markets right now and some people believe that holding gold will be a hedge against the fact that they view many other investments as being risky and hard to predict at this point."

Yes. That's why people are buying and holding onto gold: economic uncertainty. It's not inflation. What happens? The economy is struggling. Despite some modest economic growth over the past three quarters, the unemployment rate is close to the highest point since the Great Depression. Threats remain from home and abroad from foreclosures and underwater homes to heavily indebted European economies and heavily indebted consumers. Many have wisely moved some of their portfolio out of the stock market and into less risky treasury bonds and gold. The fact that many are moving their investments towards gold AND treasury bonds would indicate that inflation is not a major concern of investors right now because treasury bonds get creamed by high inflation.  Kudlow misread it.

Is inflation a concern for the future? Of course. Inflation is always a concern. If the Fed maintains its easy money policy in a normal economic environment, then you'd better believe that inflation would be a serious threat. But there are no current indicators of any threat of inflation. Kudlow, through his ignorance of basic economic principles, misread the indicators.

You Say Goodbye, I Say Hello – The Supply Side Debate

Last month at NationalReview.com Kevin Williamson, deputy managing editor of National Review, and Alan Reynolds, a senior fellow with the Cato Institute, traded opinions on the state of supply side economics. Reynolds’ article was in response to Williamson’s, and his tone seems to suggest that he’s arguing against Williamson. But an analysis of both columns reveals that the two are surprisingly in agreement on all points.

Williamson wrote the first column. He argued that tax cuts are merely tax deferrals unless they are accompanied by corresponding spending cuts. If taxes are cut and spending continues, he contends, then eventually taxes will have to be raised. The past 30 years is a sad confirmation of Williamson’s main point.

Williamson also called attention to the false belief held by too many people that tax cuts pay for themselves and often result in increased revenues. Williamson contended that tax cuts don’t pay for themselves despite popular opinion.

Reynolds writes his column in an attempt to argue against Williamson. He starts off taking Williamson’s quotes out of context and attacking arguments that Williamson never made which is forgivable because evidently the law requires conservative columnists to do this. He claims that Williamson implies that “it makes no difference whether the budget is balanced by curbing spending or increasing taxes”. Williamson never implied this. To the contrary, the theme of Williamson’s article is the damaging economic effects of irresponsible government overspending.

Reynolds adds a reference to a 2002 study that found that the surest way to make economies boom is through deep cuts in government spending. This affirms part of Williamson’s argument, that overspending is the problem that should be addressed. Reynolds goes on to admit that the deficit reduction in the 1990s was mainly because of cuts in defense spending.

Both Williamson and Reynolds are in total agreement that irresponsible government overspending is detrimental to economic growth.

They’re also in agreement over the effects of tax cuts. Both agree that tax cuts don’t “pay for themselves” but that a portion of the lost revenue is made up by increased revenues from economic growth as a result of tax cuts. Williamson cited a study that estimated the effect to be between 1 and 32 percent (depending on the type of tax cut and the extent). Reynolds cherry picked an analysis that cited 40 percent. So the two are in agreement over the stimulating effects of tax cuts; they only differ on a few percentage points of the effects.

Where they differ is on a point mentioned by Williamson regarding the exaggeration of the effects of tax cuts. One example is a comment by Reynolds. Reynolds claims that most of the revenue gains in 1997–2001 were the result a decrease in the capital gains tax rate of 8%. Notice the period chosen by Reynolds. It’s not uncommon for hack economists to conveniently choose a period that supports their pre-drawn conclusion, I find. Reynolds chose the period of the dot com bubble when capital gains tax revenues skyrocketed. He did not extend that beyond 2001 when the bubble burst and capital gains tax revenues tanked. Reynolds uses this to prove his contention that reducing capital gains tax rates by 8% results in a windfall of capital gains tax revenue.

Williamson named names: George W. Bush, John McCain, Rush Limbaugh, and even Steve Forbes, Williamson claims, have regurgitated the incorrect statement that reducing tax rates results in increased tax revenue. It started by politicians campaigning on tax and spending cuts. We got the tax cuts, but we never got the spending cuts. The deficit grew. It’s to the point now where they’re trying to tell us that cutting tax rates actually increases revenue. Vote for me, they say. The national debt continues to grow.

Now we’re in a hole. We are in such a hole that it’s going to take not years but decades of serious belt tightening to get ourselves out of this, and some people like Reynolds and Larry Kudlow wish to continue with the same policies that got us into this mess. Encouraging though are people like Williamson and Bruce Bartlett who recognize that the policies of the past 30 years were wrong. 

Short-Sighted View of the Pursuit of Happiness

http://tinyurl.com/3a3tevu

President of the American Enterprise Institute Arthur C. Brooks writes a column at National Review.com that outlines a very narrow minded, ignorant view of happiness. To sum it up, Brooks says that making a lot of money is the key to happiness.

Like most columns by conservative columnists these days, he starts of criticizing President Obama. At a commencement address in 2009 President Obama encouraged his audience not to “chase after all the usual brass rings”. He said that this has been in our culture for too long and that we could do better.

It kind of reminds me of Romans 12:2 “Do not conform any longer to the pattern of this world, but be transformed by the renewing of your mind. Then you will be able to test and approve what God's will is—his good, pleasing and perfect will.”

Needless to say, Brooks disagreed. He went on to argue that materialism and the pursuit and accumulation of wealth will not only make the individual happy but that each individual’s personal pursuit of happiness and wealth is what’s best for society as a whole. Brooks expends a lot of words criticizing Obama’s policy of wealth redistribution which has nothing to do with Obama’s speech, but he uses it to explain his premise that redistributing wealth does not make the recipient “happy”. Rather earning wealth is what brings happiness. “People who feel they have earned their success are much happier than people who feel they have not,” he writes.

And he had evidence to support his thesis. He cites a 1996 study that found that people who thought they were successful were more likely to consider themselves “happy”. A 2001 study found that people who believed they were successful were less likely to feel sad.

He pointed out that money itself does not make people happy, but success is what makes people happy. He said that money “is merely the symbol of earned success”. He offered that the best way for someone to achieve happiness is by working hard through the free enterprise system which is “not just a money machine — it is a happiness machine.”

It’s obvious that he missed the whole point of President Obama’s speech. The fact is that it is a major part of our culture the belief that working hard and making a lot of money is the key to happiness, and it is also a major part of our culture that one’s own personal happiness should be one’s primary goal in life.

Why?

Why am I so important that my goal in life should be my own personal happiness? Is that what life is about? The truth is that we live in a society where the individual ego is at the forefront, where each individual is taught to serve his or herself and that “me” is the most important person in the world. Striving to achieve wealth, success and happiness for myself should not be my primary goal.

Another part of our culture that we should be encouraged to avoid is the consumer culture. I want what I want. I have to wear the right clothes to fit in. I have to keep up with the Joneses. I want a Vegematic. I want a Pocket Fisherman. I want a handy appliance that'll scramble an egg while it's still inside its shell. Our culture has us working jobs we don’t like and/or going into debt to buy things we don’t need.

But the Bible teaches something different.

Romans 12: “Therefore, I urge you, brothers, in view of God's mercy, to offer your bodies as living sacrifices, holy and pleasing to God—this is your spiritual act of worship. Do not conform any longer to the pattern of this world, but be transformed by the renewing of your mind. Then you will be able to test and approve what God's will is—his good, pleasing and perfect will. For by the grace given me I say to every one of you: Do not think of yourself more highly than you ought, but rather think of yourself with sober judgment, in accordance with the measure of faith God has given you. Just as each of us has one body with many members, and these members do not all have the same function, so in Christ we who are many form one body, and each member belongs to all the others.”

Philippians 2: “Do nothing out of selfish ambition or vain conceit, but in humility consider others better than yourselves. Each of you should look not only to your own interests, but also to the interests of others. Your attitude should be the same as that of Christ Jesus: Who, being in very nature God, did not consider equality with God something to be grasped, but made himself nothing, taking the very nature of a servant, being made in human likeness. And being found in appearance as a man, he humbled himself and became obedient to death— even death on a cross!”

The Bible teaches that we should NOT seek our own interests of personal happiness and wealth. Look not only to your own interests but also to the interests of others. Don’t think of yourself more highly than you ought. Think of yourself as a member of one body with many members each member belonging to the others. And consider others better than yourself.

The President was right. We can do better than what our culture instructs us.